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Portfolio > Economy & Markets > Stocks

Get Ready for Another Wild Ride in Q2: Schwab Strategists

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Expect more of the same in the second quarter. That’s the key message of Schwab investment strategists in their recent take on the coming three months.

“Investors were taken on a wild ride through the first quarter. However, the second quarter is starting within shouting distance of the year’s starting mark. We believe the trend is generally higher, but bouts of volatility are likely to persist,” stated Liz Ann Sonders, Brad Sorensen and Jeffrey Kleintop, in a report released Friday.

And yes, more of the same includes further political developments.

“Potential Federal Reserve action will likely stay at the forefront of investors’ minds, with some conflicting messages coming after its recent meeting adding to the consternation. This being a presidential election year could make things a bit more interesting as we march toward November,” the Schwab analysts wrote.

On the bright side, emerging markets “have surged ahead, aided by a weaker U.S. dollar,” they point out. But while this action has “been encouraging,” future gains in this group depend on improving global growth.

Q1 Performance

The past quarter involved lots of jitters, though the Standard & Poor’s 500 index ultimately gained 1.3%.

“We saw ramped up fears of both a global and domestic recession push stocks substantially lower and into correction territory,” Sonders and her colleagues said.

On Feb. 11, though, a rally “brought equities back to within shouting distance of the flat line for the year. Recession fears faded with better data, and sentiment was aided by a dovish Federal Reserve meeting that saw forecasts for rate hikes this year move to two from four,” they explained.

Meanwhile, emerging market bonds and equities (as measured in U.S. dollars) improved 8.5% and 5.7%, respectively. Gold, however, outran these strong performers with a 16% jump in the period.

“Commodities also staged a nice turnaround, aided by a flattish to slightly weaker U.S. dollar, while oil and stocks continue to trade in pretty tight lockstep,” the Schwab strategists explained.

Sticky Stocks & Oil 

The group is cautious on stocks, given the deep connection between today’s equity performance and low energy prices.

“We remain neutral on equities — meaning investors should remain at their long-term equity allocations — and believe 2016 is shaping up to be much like the first quarter, volatile at times but generally trending higher,” they stated.

“As long as the oil/stocks correlation remains elevated, continued improvement in the stock market may hinge on the path of oil prices. With oil inventories at historic highs and the ability of oil rigs which have been shuttered to restart in relatively short order, it’s tough to paint a picture of oil moving substantially higher from here over the course of the year,” the Schwab strategists said.

On the upside, low oil prices often has a positive impact on growth in GDP, “which could bode well for potential upside surprises in 2016,” they add.

These days, however, many companies appear reluctant to spend money on capital improvements.

“Their preference appears to be adding to the labor force as 215,000 jobs were added during the month of March. The calculation appears to be that given the uncertainty of economic developments, companies believe it’s easier to lay off employees if necessary, rather than trying to get rid of equipment at fire sale prices,” explained Sonders, Sorensen and Kleintop.

Given the current climate, they expect the upcoming earnings season to be “relatively weak, with another negative growth rate expected.”

The Schwab team sees stocks as fairly valued, so stronger earnings “are likely needed before stocks can move demonstrably higher.”

The group also says there are signs that inflation is “ticking higher.” While that could boost profit margins, wages look like they are moving higher, too; average hourly earnings rose 2.3% year over year in the latest government report. Manufacturing, though, “appears to be stabilizing and even showing some signs of returning to growth,” the Schwab strategists say. Plus, the U.S. consumer “continues to look healthy, with low energy prices, low unemployment, higher wages and reduced debt loads.”

Still, consumers “are maintaining a deleveraging mindset,” and that suggests just modest U.S. economic growth, according to the group’s latest outlook: “Housing has been a strong point but has recently shown signs of leveling off a bit as existing home sales fell 7.1% in February [from January], but did rise 2.2% year over year according to the National Association of Realtors; while new home sales rose a relatively benign 2.0% according to the U.S. Department of Housing and Urban Development.”

Fed Fodder

Given the “relatively muddied picture,” Sonders and her colleagues say, it is logical that Federal Reserve Board members are in disagreement over the course of monetary policy.

“The April Fed meeting is not off the table for a hike, but June seems more likely,” according to the Schwab outlook. “We continue to believe the Federal Open Market Committee (FOMC), in general, wants to get to a more ‘normal’ level of interest rates but that they’ll continue to be cautious about how they go about it. As we’ve shown in the past, historically, stock performed much better when the Fed was moving slowly, as will likely be the case this cycle.”

Political Turmoil

Another contributor to volatility, they point out, is the ramped-up political rhetoric.

“While it may be discouraging at times, resist the urge to think all is lost, or believe those that say it’s never been this bad,” the Schwab strategists say.

“According to the Republican National Convention, there have been two contested contests in recent history, neither of which resulted in the dissolution of the party, while the Democrats managed to survive their very turbulent 1968 convention that at least partially contributed to riots in the streets of Chicago,” they said.

Their main message is that investors should “stay calm,” adding that the election should “not be a major market volatility contributor.”

While the first quarter was a “proverbial roller coaster,” the Schwab team still believes U.S. stocks are “in a secular bull market; but in a more mature phase which will be dotted with volatility and pullbacks.”

There’s a need for better earnings, more clarity from the Fed and an improvement in the political environment.

The Fed’s more dovish tone “has aided in some recent dollar weakening, which has boosted emerging markets’ performance,” Sonders and colleagues say. “While it is an encouraging development, stay disciplined and diversified as we watch to see if global growth can improve.”

As the team stated last fall, investors should not mistake the 20% rebound in emerging markets over the past two months “as an all-clear sign to overweight this asset class in their portfolios.”

— Check out What Doesn’t Kill Bull Market in S&P 500 May Make It Stronger on ThinkAdvisor.


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